From the normal meaning of the words I would have assumed that items that become bound to you on equip are unremovable, but that doesn't seem to be the case. I can take off bound armor, and I can sell it to the in-game vendors. So I have two questions:

What exactly is the difference between bound and unbound items?

What determines whether an item will bind? Is it random, or arbitrarily chosen by BioWare per item?

4 Answers
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Bound items are a feature implemented in MMORPGs to avoid abuse of twinking.

Bound items are designed to prevent them from being shared with other characters, to avoid easily making overpowered lower level characters. If you have a bound item, it can (generally) be sold to in-game vendors, but it cannot be traded to another player.

Unbound items, however, can be freely traded from player to player, and can be used by players who aren't the ones who initially obtained the item (whether from quest, random drop, or by purchasing it from a vendor), assuming that the player meets all of the other requirements for the item.

Bound and unbound is not random. Quest items are typically bound, as they are the reward for that character completing the quest, and therefore it is expected that that character will be the one to use it. The same applies for specific reward drops from difficult encounters, such as raid or group instances.

Hmm, interesting that some items also have a specific level requirement. So items that are bound on equip can be traded after pickup if they haven't been used? What's the rationale there?
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Matthew ReadDec 19 '11 at 16:46

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@MatthewRead - well, the big one is that you might not be able to use the item with the character you found the item (Finding a Heavy Armor item on your Jedi Consular, for instance).
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Raven Dreamer♦Dec 19 '11 at 16:47

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I think twinking is secondary...mostly it's just to keep the in-game economy from totally crashing
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Nick TDec 19 '11 at 16:50

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@MatthewRead in addition to Raven's example, it may simply be that you don't want the item (it isn't an upgrade over what you are already using). In some cases, an item could conceivably be an upgrade for you, but might be worth more to you if you sold it to another player.
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BeofettDec 19 '11 at 16:55

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It's worth noting that in TOR items are bound to your character and their companions, so (as long as they meet other requirements, such as armour ability) you can pass your old weapon or armour onto your companion characters even if it's bound to you.
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GAThrawnJan 4 '12 at 2:42

To answer the second point, it is based on the item. Many boss drops will be "Bind on Pickup" That means whoever wins the roll will have that item bound to them, they cannot trade it, they can only sell it.

Other items, will have a "Bind on Equip" tag. This means that they can be freely traded until someone equips that item on their character page. Afterwhich the item is then bound to the player and follows the can only be sold/reverse engineered.

Bound items cannot be traded with other players, but can be removed, stored, or upgraded for your character like any non-bound item.

They are a staple of most modern MMOs (and some that aren't, like Diablo II), and they prevent players from easily transferring power from one character to another. Level or stat requirements are in a similar vein.

This is answering one facet of the question as the other facet seems to be answered sufficiently.

Going on the system used on other MMOs:

"What determines whether an item will bind? Is it random, or arbitrarily chosen by BioWare per item?"

This can be broken down into three questions:

Is it highly valuable/desirable?

Would the sale of the item de-stabilise the economy, if done on a large scale?

Would it create a "default" gear setting for all characters able to use it?

The first question would cause any gear not bound on pickup to be farmed for credits. If particular NPCs were found to drop the item they could be camped by same said farmers.

The second is pretty intricate to show real numbers on, but, linked to the above, those farmers would gain impressive enough wealth to influence the market above and beyond what is safe for one entity to have.

Thirdly, if everyone has the same gear we would all walk around looking alike, "Attack of the Clones"!!!! Making something BOP stops this from happening to an extent.